How much do you really need for retirement?

Retirement Jan 01, 2019

Happy New Year! With 2019 here, you are yet another year closer to retirement. Recently, the idea of retiring before 62, which is the earliest age to receive retirement benefits, has become more popular. Or maybe you just want to enjoy the work you do without worrying about financial constraints.

Ultimately both retiring early and freedom from financial constraints can be achieved through understanding how much we need for retirement.

We can calculate how much we need for retirement with the 4% withdrawal rate. The 4% is the rate at which retirees are able to safely withdraw from their nest egg without exhausting all their investments. This nest egg includes all our savings for retirement including IRA, 401(k), brokerage, and any other financial accounts.

The best way to describe the 4% withdrawal rate is if you have $1,000,000 saved for retirement then you can withdraw $40,000 ($1,000,000 * 4%) in retirement every year.

The rule is derived from the 1998 paper, Sustainable Withdrawal Rates From Your Retirement Portfolio by three professors from Trinity University. Going forward, we will refer to this paper as the Trinity Study.

The basis behind the Trinity Study was to answer three questions related to maximizing the number of years that we can continuously withdraw from our retirement accounts before reaching $0:
1) How many years can we withdraw?
2) How much can we withdraw each year?
3) What are our stocks and bonds allocation?

The Trinity Study is dense and reads like a research paper. Luckily for you, we will decipher the paper for you. To keep our findings simple, we will only look at inflation adjusted data, which is more realistic for our investments.

Historical Data and Assumptions

The study utilizes the Standard & Poor’s 500 Index data from 1926 to 1997, which is a popular index that investors still use today to gauge how the market is doing. For bonds, there is a mix of corporate and government treasury bonds.

It is assumed that retirees will rebalance their portfolio every month based on the given allocation. Retirees will also withdraw money every month. The withdrawal is adjusted for inflation, which allows us to maintain the same standard of living.

Understanding the Research and Conclusions

This chart is pulled straight from the Trinity Study and encompasses the conclusion of their research. At first glance, it can be confusing. We promise you, it is not that bad.

The leftmost column (Payout Period) represent the stocks and bonds allocation and the number of years we can withdraw without working another day. We should focus on the the rows with 30 years because we cannot predict our death. The longer we can live off our retirement savings, the better.

The top row (Annualized Withdrawal Rate as a % of Initial Portfolio Value) represents how much we can withdraw each year.

The data entries in the center represent the success rate of the portfolio. A portfolio is considered a success when it does not reach $0 by the end of the retirement years. We want our success rate as high as possible. We will focus on success rates higher than 95%.

The 3 Answers We Care About

This is a bar graph illustrating the values we care the most about: high success rates, withdrawal rates, 30 year payout period, and the different stocks and bonds allocations.

According to the Trinity Study, the best option for a 30 year period is a 75% stocks/25% bonds allocation with a 4% withdrawal rate which has a 100% success rate.

We can tell right away that a 100% bonds allocation is not a good move because the success rate is less than 80% in all scenarios.

A 5% withdrawal rate seems pretty risky since in all situations the success rate is less than 90%.

A 3% withdrawal rate has a 100% success rate in all scenarios except 100% bonds allocation. At first it seems like the best option, but it also means we have to save significantly more.

For example, if we still wanted to withdraw $40,000 each year in retirement, then we need $1,333,333.33 ($40,000 * 100 / 3). That is significantly more than the original $1,000,000 we needed for a 4% withdrawal rate.

We need to keep in mind, two things regarding allocation. Stocks refer to index funds and NOT individual stocks. The 75% stocks / 25% bonds allocation is only during retirement.

Otherwise prior to retirement and in the wealth accumulation phase, we can focus on investing in total market index funds and leave bonds for retirement.

To figure out how much money we need before retiring with the 4% withdrawal rate, we can use the formula below:

Yearly Expenses in Retirement * 25 = Minimum Amount for Retirement
$40,000 * 25 = $1,000,000

The Study is Not Perfect

There are three caveats in this study we need to be aware of:
- Does not factor in taxes on withdrawals
- Does not factor in investment fees
- 100% success rate is not guaranteed

A good portion of our withdrawals during retirement can be taxed depending on the type of investment account we have. This is hard to predict as not everyone has the same set of tax advantaged accounts.

Investment fees are also difficult to predict because it depends on the brokerage. The current trend seems to be lowering investment fees, which is great for us. In most cases, investment fees are not $0 and will affect our retirement.

We need to keep in mind, the Trinity Study was performed with historical data from 1926 to 1997. This includes the Great Depression and World War II, both of which negatively affect market growth. Past performance is not an indicator for future performance. 100% success rate is not absolute certainty.

These caveats mean we need to save more than what the 4% withdrawal rate states. At the very least, we still know the minimum amount for retirement.

As the saying goes, stuff happens. We can’t predict the future, but we can prepare for it. This is one of the best guides we have for retirement and understanding how much we need to save to achieve the lifestyle we want.

If you would like to request a specific topic you want to learn more about, please let me know in the comments section below or email me at!

Cover Image: unsplash-logoSamuel Isaac

DISCLAIMER: This blog references an opinion and is for information purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice. This blog makes no representations as to accuracy, completeness, currentness, suitability, or validity of any information on this site and will not be liable for any errors, omissions, or delays in this information or any losses, injuries, or damages arising from its display or use. All information is provided on an as-is basis. Please do your own comprehensive research before investing in anything.


Alan Chen

Hi! One day, I will build a technology company that will change the world. Right now my focus is teaching personal finance. Now that you know a little about me, feel free to reach out and chat!

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